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WORKING PAPER

ALFRED P. SLOAN SCHOOL OF MANAGEMENT

EXPORT PROMOTION AS A DEVELOPMENT STRATEGY

By

Julio J. Rotemberg-

WP#178i»-86 May 1986

MASSACHUSETTS

INSTITUTE OF TECHNOLOGY50 MEMORIAL DRIVE

CAMBRIDGE, MASSACHUSETTS 02139

EXPORT PROMOTION AS A DEVELOPMENT STRATEGY

By

Jul io J. Rotemberg"

WP#1 784-86 May I986

"Sloan School of Management, M. I .T. I wish to thank RudigerDornbusch, Paul Krugman and Garth Saloner for helpful

discussions.

EXPORT PROMOTION AS A DEVELOPMENT STRATEGYABSTRACT

This paper has two aims. First it presents a model of the advantagesof promoting exports. Second, it warns that in such a model, exportpromotion may be of benefit only to a limited group of countries.Encouraging others to become outwards oriented may be detrimental to

welfare. The fact that, for the exporting sector to be viable, thescale of the exporting sector must be large relative to the optimalscale of exporting firms is advanced as the motivation for exportpromotion. 1 then argue that the scale of the exporting sector may, in

equilibrium, be a signal of the export good's quality. Largecapacities in the sector are required to convince importers to payhigh prices. Such high capacities may effectively deter countriescapable of producing only low quality goods from subsidizing exports.

T INTRODUCTION

This paper has two aims. First it presents a model of the

advantages of promoting exports. Second, it warns that in such a

model, export promotion may be of benefit only to a limited group of

countries. Encouraging others to become outwards oriented may be

detrimental to welfare.

It is widely recognized (see Bhagwati (1978), Balassa (1980) for

instance) that less developed countries that have emphasized exports

have grown faster than those who have continued to rely on import-

substitution. Balassa (1980) says: "The evidence is quite conclusive:

countries applying outward-oriented development strategies perfomed

better in terms of exports, economic growth and employment than

countries with continued import orientation". He, and many others,

view the success of such outward-oriented economies as Korea and

Taiwan worth emulating and recommend that those nations who are still

clinging to import substitution change their ways.

It is important to point out at the outset that the policies

followed by the successful outwardly oriented nations has not been to

dismantle the edifice of tariffs erected by previous policies.

Instead, they have added to this edifice various measures designed to

promote exports. Thus, it is the export promotion itself which must

have been the source of their new riches. This, in itself, is

paradoxical in light of the standard 2X2X2 trade models. In these

models, it is weU known that export biased growth tends to worsen the

terms of trade and can even lead to a loss in welfare (Bhagwati

(1956)). Reliance on exports also leads to more exposure to the risk

-3-

of protectionism.

In fact, there has been little formal theorizing about the

advantages of export promotion. Bhagwati (1978) stresses two ideas.

The first is that countries with export promotion policies have fewer

distortions. While this may be true, aggregate statistics like those

in Balassa et al. (1982) undoubtely mask considerable variations in

incentives across individual products and industries. The second is

that capital inflows are easier to obtain when following an outwards

oriented strategy. Yet, of the outwards oriented countries, foreign

capital inflows appear to have been important only in Korea. Now,

Korea may well have a debt problem.

Section II of this paper presents a different rationale for

export promotion. It rests on the notion that exports may only become

profitable when they are carried out on a scale larger than the one

that is optimal for a single firm. There is then an externality: one

firms' increase in exports makes other exporters more viable. The

effects of this externality can be mitigated with export subsidies.

This model could in principle be used to argue that all countries

should subsidize exports. Yet, one must be suspicious of this

recommendation given that so many countries have chosen not to

subsidize their exports even after seeing the same data as Bhagwati

(1978) and Balassa (1980).

I think it is at least plausible that those countries that have

chosen not to subsidize their exports have done so in the pursuit of

their own self interest. Thus the model I present has the feature

that for certain countries, exports would not be profitable even in

relatively large scale. The model also seeks to explain the

determinants of the relatively large scale that must be built up

-4-

before export industries become viable even in those countries in

which exportts are ultimately succesfull. It shows that the capacity

installed in the export sector may serve as a signal (in the sense of

Spence (1973)) of the quality of the exportable good. Countries

intrinsically unable to produce good quality products would be willing

to subsidize a small amount of capacity in the export sector to mask

themselves as good quality producers. Then, at least temporarily,

they would obtain high prices for their products. However, there

exist equilibria in which the level of capacity in the export sector

that is required for importers to infer that the good is of high

quality is so large that only countries capable of producing high

quality goods would build such capacity. At these equilibria,

countries that know themselves to be unable to produce high quality

exportables abstain from promoting exports.

Starting at these equilibria, it may well be ill-advised to

convince all nations to subsidize their exports. This not only leads

countries to produce inappropiate goods but also, by eliminating the

information contained in the installed capacity, may lead countries

who can produce high quality goods to receive lower prices for their

output. Alternatively it makes these countries worse off by forcing

them to subsidize their export industry more. They must do this to

differentiate themselves from other countries. This argument is

developed in Section III. Section IV closes the paper with a caveat

to the argument that encouraging countries to promote exports only

leads countries that are high quality exporters to be worse off. It

presents a model which is technically similar to the one in section II

in which high capacity in the export industry is needed to export

efficiently. Then only those countries that find the necessary

-5-

subsidies to the export sector very distortionary will abstain from

export promotion. Transfers to such countries with the condition that

they promote exports do not hurt other exporting nations in the

absence of terms of trade effects.

II THE MODEL: EQUILIBRIUM EXPORT PROMOTION

I consider one good, say TV sets, which is potentially exportable

from country A to country B. This good can be of two qualities,

consumers in country B are willing to pay more for the good if it is

of high quality. Country B's customers are wUling to pay P for TV

sets if they are known to be of high quality. They are willing to pay

only P for low quality sets. Thus, I ignore the deleterious terms of

trade effects that export promotion can bring about. There are two

periods. In the first period quality is not observable by the

customers. However, they can make inferences on the good's quality by

observing installed capacity. I assume initially that consumers infer

the good is of good quality only if the capacity instaUed in the

producing country equals at least K ; otherwise they infer it is of

low quality. For this to be the case, the level K must be such that

countries capable of producing high quality goods (h-countries)

Install, in equilibrium, a capacity of at least K while others do

not. This will later be shown to be true for certain values of K .

In the second period, having already experienced the good, customers

in country B know its quality.

To ensure that collective action is needed to achieve a capacity

of K , I must assume that it is costly for firms to grow large. The

simplest way of modelling this is to assume that capacities above some

level k'" are prohibitively costly while k is smaller than K . 1 thus

assume that n firms have access to a technology which enables them to

build a capacity of k at costs given by:

ck k < k"™ , k"" < K^ , nk'" > K^

k > k"" (1)

m hwhere the condition that nk exceed K is necessary to ensure

that it is socially possible to produce K . Having built a capacity

of k, these firms can costlessly produce k units in both periods but

cannot produce more than k units in either. I now consider whether

any of these n firms would, individuaUy, choose to produce for

export. Doing so would yield profits of it if the firm is in a high

quality country and of ti if it is in a low quality one:

TF^ = (P^ - c + Rr^)k k < k"™

TT^ = (p^ - c + RpV k < k""

(2)

h . . , i 1 J hwhere R is a discount factor and r is a price between p and p .

Thus, high quality firms do receive somewhat higher prices in the

second period as their high quality becomes known. For collective

h 1

action to be needed it (and a fortiori) it ) must be negative for

nonzero k. It is important to point out that for it to be negative,

which is the case I consider, one of two conditions must hold.

Either, the future must be heavily discounted so that future high

prices are nor enough to induce firms to invest or customers must be

slow in learning from those that have experienced the good that good

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quality is being produced so that r is low . In this case, when a

single producer installs some capacity that capacity is insufficient

to convince buyers that good quality will be produced. This makes

buyers pay little and thus leads to losses for producers.

Consider instead the profits to a firm that has a capacity of k

while other firms, together, have a capacity of (K -k ). Its profits

are W if it is located in an h- country and W otherwise:

,,h ,h ^„h,,mW = (p - c + Rp )k

W = (p - c + Rp )k

(3)

Note that even firms located in countries that produce low

quality goods (1- countries) get paid p in the first period when

installed capacity is large. Unless W is positive, production of the

good is never socially beneficial. Similarly, unless W is positive

it is never in the interest of 1-countries to produce the good. For

W to be positive (p +Rp ) must equal or exceed c which again requires

that the future be significantly discounted. 1 start the analysis by

studying the incentives to invest in h-countries.

With TT negative and W positive there are two equilibria if all

firms must invest simultaneously. The first has no production for

export. No firm finds it optimal to invest in capacity because, if it

is alone, it will be paid little and make losses. The second has

production of Q . Then, each firm has an incentive to invest because

sufficient capacity is available to ensure high prices. The presence

of these two equilibria is akin to the multiplicity of equilibria that

arise in the context of adopting superior telephone systems (see

-8-

Rohlfs (1974)). There too, adoption of a system by others makes

adoption more attractive.

Another possibility, considered in FarreU and Saloner (1985a) is

that the adoption decisions are made sequentiaUy but the adoption

Itself occurs simultaneously. This requires that there first exist n

decision periods in which firms decide whether to invest or not. After

this round of periods is over, all the firms invest simultaneously.

Then the unique equilibrium when W is positive is for firms to invest

since they can always expect the last firm to decide to invest if all

the previous firms have decided to do so.

Yet, a more natural dynamic setup in the context considered here

is that firms both decide and invest sequentially. Then, firms that

invest early earn ti at first even when other firms follow. In this

case no firm wiU want to invest early and it is natural to expect the

only equilibrium to be the one in which all firms refrain from

producing for export. This leads me to assume that in the model

presented here the equilibrium with no investment wUl prevail when it

exists.

The government can easily eliminate this equilibrium by

encouraging firms to invest in the export sector. In principle, one

way of doing so is to promise the first K /k firms that they wUl be

paid p^ if they export the good. This is essentially the solution

proposed by Dybvig and Spatt (1983) for the problem of adoption

externalities. Once firms are promised p , they wiU invest in the

requisite capacity if W is positive. Moreover, once they invest in

capacity, the price will automatically equal p so the government

would, in principle, incurr no cost. This policy has the danger that,

unless the government is very precise as to the nature of the good for

-9-

which it ensures a price of p ,firms may produce shoddy and cheap

goods to take advantage of the government's program. On the other

hand, precise government dictated specifications may lead to

Inappropiate product designs.

An alternative remedy which would appear to be much more flexible

is to subsidize the capacity and/or production of the export industry.

Indeed, subsidization of credit to exporting industries and other

export subsidies such as tax rebates are widely used policy tools in

3outward oriented economies such as Korea . The question is still why

the government does not, as in Dybvig and Spatt (1983) make the

susbsidy contingent on the export drive being unsuccesfull. There are

two related reasons for this. The first is that promises by the

government that it will subsidize an industry only if Its export drive

is unsuccesfull are probably not credible. This is particularly true

if, as below, there are deadweight costs associated with the taxes

needed to finance the subsidy. Then, ex post , it will not be in the

governments' interest to pay the susbsidy if the drive is

unsuccesfull. The second reason is that it is somewhat hard to

specify what it means for an export drive to be unsuccesfull. For

instance it would be necessary to consider the possibility that random

variations in demand or supply would affect measured export

perfomance. By comparison, it is relatively easy to give subsidies

contingent on certain export capacity being installed.

For the model considered here, a subsidy of s per unit of

capacity constructed is necessary to induce any single firm to produce

for export where s equals

:

s = c - p - Rr (4)

10-

With this subsidy a single producer breaks even. Since this

subsidy induces many firms to enter, industry capacity will exceed K

so that firms will receive a price of p in both periods. Thus the

subsidized firms will earn rents equal to N:

N = [p^(l ^ R) - c . shjk'" = [p^ - p^ ^ R(p^ - r*^)]k'" (5)

so that profits net of subsidies equal W . Note that the subsidy

need only be given during the period in which the industry is

establishing its credibility. This accords well with the Japanese and

Korean practice of giving subsidies to specific industries for a

4limited time only.

The subsidy given by (4) benefits the industry. However, I

assume that nations only offer this subsidy if the benefits to the

industry exceed the social costs of the subsidy. The social costs

include the total expenditures on subsidies S as well as the cost of

the distortions induced by the subsidy d(S). There are two obvious

sources of this distortion. The first is that resources must be spent

administering the subsidy. In particular the government must verify

that capacity for legitimate exportable production is built. Second,

distortionary taxes must be raised to finance the subsidy. Thus,

larger value for S which requires more taxes and more administration

raises d. Under reasonable assumptions the function d is not only

increasing but also convex. For instance, suppose the government

chooses taxes with the objective of keeping deadweight losses low.

Then, the deadweight loss from each successive doUar of taxation is

progressively bigger so that d is convex. Similarly, if there are

-11-

diseconomies os scale in administering a subsidy program (because, for

Instance, the incentive for fraud becomes larger as the program is

larger) d becomes convex. The total subsidy for an h-country, S can

either be given by ns k if it is granted to aU the firms or by s K

if it is granted only to enough firms to ensure that local firms

receive the price p . This second alternative is theoreticaUy more

attractive although it may be more difficult to implement in practice.

Thus 1 assume only that the total subsidy S is an increasing function

of K . The profits of each firm net of subsidy equal W so that the

social benefits of the subsidy, B , equal:

B^ = nW^ - d(S^(K^)) (6)

Unless B is positive, export promotion is never socially

beneficial so that I concentrate on the case in which nW exceeds

d(S^(K^)).

I now turn to the incentives faced by the country that produces

low quality goods. It too, can ensure production for export by giving

a subsidy. However, the subsidy that makes individual producers

wUling to export equals s :

s^ = c - p^(l + R) = s^ + R(p^ - p^ (7)

which exceeds s . The net benefits of susbsidizing exports in

the 1- country are given by:

B^ = nW^ - d(s\K^)). (8)

-12-

where s\ the expenditure on subsidies is again assumed to be

increasing in the capacity that must be susbsidized K .The benefits

to the h-country B^ exceed B for two reasons. First, W is smaller

than W^. Second, if both countries subsidize the same number of units

S^ exceeds S^ so that d(s\K*^)) is bigger than d(S (K )). More

importantly, since, s^ exceeds s and the function d is convex, each

additional unit that is subsidized reduces B more than it reduces B.

This is shown graphically in Figure 1. There, the benefits for both

types of countries are shown as functions of K under the reasonable

assumption that a higher level of K requires the subsidy of more

units to get the export industry started. If W is positive, as in

the figure, there is a range for K (between zero and K') in which it

appears socially beneficial to subsidize the export industry even in

the 1-country. Even then, for K above K', export promotion is, at

most, socially optimal in countries that produce high quality goods.

This is true for all positive K if W is negative.

In figure 1 there is always a level of K between K' and K" in

which promotion is optimal for the country that produces high quality

goods but not for the other. This however, requires that K' be below

nk"*. Otherwise, the maximum feasible value of K makes it worthwhile

for the l-country to promote exports.

I now come to the rationale for paying a high price only to goods

produced in countries whose capacity exceeds K . This rationale rests

on the inability of purchasing countries to know much about the

quality of goods from newly industrializing nations. Such lack of

information is particulaly compelling when one interprets quality

broadly to include not only the reliability of the final product but

also the promptness with which delivery will take place, the

-13-

flexibility of the suppliers to accomodate changes In desired design

etc. In the absence of much other information about quality, the

level of installed capacity might weU become a useful barometer. In

particular, in the model presented thus far, as long as K^ is above K'

only governments of h-countries find it optimal to promote the export

industry. Therefore, if governments are both informed about the

quality of the goods that their countries can produce and act in the

national interest, a level of K above K' separates the 1-countries

from the h-countries. Governments that know good quality is

forthcoming can signal this (as in Spence (1973)) by subsidizing

capacity and customers can thus be assured that only h-countries have

the requisite capacity.

This leads to two questions. First, is it reasonable to assume

that governments are relatively well informed about the quality of the

goods producible in their countries? Second, can one expect them to

act in the self interest of their country? This second question is an

important and extremely difficult empirical question which is left

open for future research. In answer to the first question it must be

pointed out that governments certainly know more about the level of

skills and education of their population than do outsiders. Also,

since the government is a large employer it probably knows

substantially more about the motivation and aspiration of its

country's workers than do foreigners.

Note that, while the model has been constructed under the

assumption that governments are certain whether their industries will

produce high or low quality, this is inessential. Indeed, the same

results would obtain if governments were simply better informed about

the probability of being high quality exporters. Some governments

-14-

would have to know this probability to be high while others would have

to know it to be low. Then, governments who estimate this probability

to be high would be willing to subsidize larger capacities.

I now turn to a slightly more formal discussion of the

equilibrium values of K . First, any value of K above K' separates

1-countries from h-countries. However, as long as K" is lower than

Vi

nk , K barely exceeding K' is the most natural equilibrium since it

involves the smallest deadweight loss from subsidies. Second, values

of K below K' do not constitute equilibria in this model in the sense

that, if K is below K', importers are not willing to pay p for all

units exported by countries with installed capacity equal to at least

K . This occurs because for K below K' governments of 1-countries

would also subsidize exports if p were paid for these exports.

In addition to these values of K which promote the separation of

countries there are many "pooling" equilibria; indeed these are the

only equilibria if K' exceeds nk . At these, the capacity of the h-

countries and the 1-countries is the same so that both get the same

price p in the first period. This price p , which is received only

by countries with installed capacity of at least K is given by:

m h , , 1 .1p = ap + (l-a)p

where a is the proportion of countries that actuaUy supply high

quality goods. Suppose that the proportion of h-countries in the

population is a'. Then, even when the minimum capacity requirement

for a country to receive p in the first period, K , is zero, a will

only equal a' if:

-15-

W'^ = (a'p^ + (1 - a' + R)p^ - c) > 0. (9)

In other words, all 1- countries will choose to participate if

their proportion is small enough that, even when they all participate,

they receive a sufficiently high price. However, if a' is less than

or equal to R, the condition that ti be negative contradicts condition

(9). Then, l-countries are sufficiently numerous that, if they all

participate, they make participation unprofitable. In this case, a

will exceed a'. In particular, the proportion of l-countries that

export will be such that l-countries are just indifferent between

exporting and abstaining from exporting. This implies that a must

equal:

[c-(l+R)pV[p^-p^] + d(s\K"'))/[nk"'(p^-p^]. (10)

Note that, as K increases, the proportion of h-countries that

export must rise. This raises p and thus keeps l-countries

indifferent between exporting and not exporting. This Indifference

has important implications. In particular, it means that the

separating equilibrium (with K equal to K') Pareto dominates the

pooling equilibria. This is so because importers are also indifferent

between the two. Therefore, Pareto superiority requires only that h-

countries prefer the separating equilibrium. A sufficient condition

5for h-countries to do so is :

nk'"(p^-p"^) = nk'"(p^-pS(l-a) > d(S^(K')) - d(S^(K'")).

For a given by (10) the left hand side of this inequality is

-16-

equal to:

nW^ - dCS^K"")).

Thus the inequality can be rewritten as:

nW^ - d(S^(K')) > dCS^'CK"')) - d(S^K'")) (11)

K ' is defined as the level of capacity which makes nW equal

d(S^(K') which, in turn, exceeds d(S (K')) so the left hand side of

(11) is positive. On the other hand, since 1- countries must provide a

larger subsidy to obtain the same response by their producers for a

given K*", the right hand side of (11) is nonpositive. Therefore, the

separating equilibrium is Pareto superior for sufficiently low a'

.

Ill FORCED EXPORT PROMOTION

Countries with export promotion policies having become so

succesfull, it has become commonplace to extoll the virtues of

outwards orientation. When these praises are sung by international

gorganizations with the capacity for extensive discretionary funding

they presumably come accompanied with subsidies to countries that

7become outwards oriented . In this section I study the consequences

of these policy oriented transfers which wiU be assumed to be equal

to T. For simplicity of exposition 1 start by analyzing transfers

received exclusively by 1-countries.

These transfers shift the B line up by T. We must distinguish

between the cases in which the B ' line meets the x-axis to the left

-17-

of both nk and K" and the case in which it doesn't. In the first

case there is an equilibrium with K between the point at which the

B ' line meets the x-axis and K"

.

At this equilibrium only h-

countries find it optimal to subsidize a capacity of K . Those

countries wUl then continue to receive p for their products.

Instead, 1- countries who receive transfers wUl receive only p as

long as they subsidize only as much capacity as is in the national

interest. Note, however, that selling goods for p may now be in the

national interest even when it is negative for positive k. This is

true as long as the transfer T allows the country to give a subsidy of

s to certain units at no national cost. In this case the worldwide

loss from export promoting policies is twofold. First there is the

inefficiency of producing l-country units which equals -n with k

equal to the total units subsidized. This inefficiency is exactly

equal to the transfer T. Second there is the deadweight loss from

forcing h- countries to subsidize their export industry more in order

to distinguish themselves from 1-countries.

In the second case there is no level of capacity that

distinguishes countries with good quality from others. Then, unless a

different signalling mechanism is devised the only equilibria will be

pooling equilibria of the form considered above. At these pooling

equilibria all exporters are paid p in the first period where p is

strictly smaller than p . Thus h- countries are strictly worse off.

Moreover, as shown above these pooling equilibria are Pareto dominated

by the separating equilibrium if there are a sufficient number of 1-

countries. Then, even if they receive a transfer T for exporting, 1-

countries are indifferent between exporting and not exporting. Thus

worldwide losses equal the entire transfers to 1-countries in addition

-18-

to the losses to h-countries.

So far I have considered only transfers to 1-countries. The

analysis, however, carries over to the more realistic case in which

transfers for export promotion are received by both h- and 1-

countries. Obviously it does not apply when transfers are given only

to h-countries; they then have no effect on the separating

equilibrium. Suppose then that some h-countries and some 1-countries

receive transfers of T. This respectively shifts the B and B lines

of the 1- and h- countries that receive the transfers. So, again, in

the case in which the B ' meets the x-axis to the left of both K" and

nk"' the separating equilibrium can be maintained at the cost of

raising K above K'. Also, if it meets the x-axis to the right of nk

only pooling is possible. The new possibility that arises is that the

B^' meets the x-axis to the right of K" but to the left of nk"*. Then

if K is chosen below K" there will be pooling. If, instead K is

chosen above K" only the h-countries receiving the transfer will

Invest while the others will not. So while raising K has the ability

of ensuring that only h-countries invest it now has the side effect of

shutting out of the export market other h-countries.

IV A CAVEAT: EXTERNAL ECONOMIES

Up to this point the message of this paper has been that

subsidies to countries that engage in export promotion may well

destroy a relatively good equilibrium and make h-countries

considerably worse off without even helping 1-countries. In this

section I want to emphasize that this is only a possibility. Indeed,

a very similar model to the one in section II can be constructed in

-19-

which transfers for export promotion are not that destructive. This

occurrs if K instead of being a variable used to signal is a level of

capacity which simplifies the operation of the export sector.

Suppose that, if the export sector is smaller than K , it is

difficult to export because exports must be arranged on an individual

basis while, once the export sector is sufficiently big, trading

companies find it easier to arrange exports. Thus, while consumers

are wUling to pay p for all goods, exporting firms receive only p

If the export sector is small, so that p -p is spent on transactions

costs. On the other hand, once the export sector attains a size K ,

this transactions cost disappears.

Therefore, in all countries, profits to a single exporting firm

are given by:

TT*^ = (p\l+R)-c)k'"

which is assumed to be negative whUe profits to a firm once a

capacity of K has been established are given by W which is assumed

to be positive. Then, countries will find it in their best interest

to subsidize exports if:

B*^ = nW^ - dCSCK*^)) >

where S is the total subsidy needed to obtain a capacity of K .

Now suppose that countries differ in the distortions caused by the

same subsidies. Then, for some countries, those who start from a tax

system with few distortions possibly due to the lack of a welfare

state, B is positive while for others it is negative. In

-20-

equilibrium, only the former subsidize exports and therefore export.

Now a transfer T from the rest of the world to countries unwilling to

export otherwise has a social cost of only T if the transfer makes

countries just indifferent between exporting and not exporting.

IThe opposite is true in the model of Klein and Leffler (1981) in which

information about the good's actual quality spreads very quickly and the

future is relatively undiscounted. Then firms capable of producing both the

low and the high quality good might prefer to produce the high quality good if

the price is high enough that the stream of rents associated with high quality

production exceeds the one period benefits of low quality production. It must

be pointed out that the Klein and Leffler (1981) method of ensuring high

quality production, namely to permit the price to be quite high, does not work

lere since some firms are only capable of producing low quality and wiU thus

sell low quality goods in the first period even when the price is high.

2The possibility of this "excess inertia" is shown in FarreU and Saloner

(1985b).

3See Balassa (1982) p. 216 for a discussion of Korean policies.

4See Balassa (1982), p. 216 for example.

5This condition is only sufficient because we are neglecting the possible

benefits in the second period from the separating equilibrium. These would

accrue if, in the pooling equilibrium, information about the good quality of

goods is only transmitted imperfectly so^that the price in that period is

below p .

6See for instance IMF (1985) p. 12-13 and Clausen (1986) plO-^^

TIndeed The Economist 3/22/86 reports that World Bank "policy loans" i.e.

loans whose purpose is not to fund specific projects but to facilitate the

changing of economic policies, didn't exist in 1979 but accounted for 15-17%

of new lending in 1985.

21-

K^

Figure 1

Net social benefit as a fonctionof K , the minuTTLim capacity needed to

receive P' in the first period

-22-

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Balassa, Bela A. et al: Development Strategies in SemiIndustrialized Economies , Johns Hopkins Press, Baltimore, 1982.

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Washington, AprU 1985.

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